How does GDP perform as an indicator of economic welfare?

It can be argued that gross domestic product does not actually do a good job of what we most often use it to display: growth. There are some key aspects that are ignored through the use of GDP as a marker for the growth and welfare of an economy. It is important to clarify that growth is not necessarily good if there is the exploitation of land, labour, and capital. This is because the main aim of the economy is the provision of our welfare, so people are employed, stable prices, and sustainable growth.

Gross Domestic Product can be defined as:

The market value of all the goods and products produced or provided within a country at a given moment in time.

There are various ways to determine the GDP of a country, there is the expenditure approach or the production approach. The expenditure approach is:

GDP = private consumption + gross investment + government spending + (exports-imports)

This identifies the first issue in which GDP fails to accurately measure the welfare of an economy. The calculation of GDP at no point involves whether or not the welfare of the people has improved, GDP is used as an indicator of a standard of living because the central variables tend to attribute towards factors that improves people’s welfare within an economy. GDP should be considered as an indicator of economic activity.

The measurement of gross domestic product is considered to have externalities; in this case it is the recognition of the factors that attribute to welfare and standard of living that the measurement ignores.

  • The first issue is wealth distribution; GDP does not describe whether or not the people are truly benefitting from economic growth. This can be seen in countries such as Qatar where an insignificant percentage of the population hold all the wealth of the country, but the wealth is significant due to oil trade. Due to the manners in which GDP can be calculated it does not show whether or not growth is actually improving the welfare of the people.
  • Gross domestic product does not include non-market transactions. Examples of non-market transaction can be noted as volunteer work, where work is done by the good will of people. There is also the example of open software programmes such as Linux which has developed our approach to coding and programming even though Linux is run as a volunteer programme. Factors such as volunteer work greatly benefit society and improve the general standard of living and gross domestic fails to recognise this because it is based on wholly economic activity.
  • Non-monetary & black markets fail to be identified as a part of the economic activity in a country that would attribute to GDP. Many undeveloped economies rely on non-monetary economies, this means that trade is done through swapping goods, rather than the employment of debt instruments and banknotes. This means that the economic activity and possible welfare of people in undeveloped countries may be underestimated if based around gross domestic product. There is also the existence of black markets, which consists of trade of illegal goods or the ability to evade tax, and as a result there is the underestimation of GDP.
  • Another difficulty with attributing GDP to economic welfare is the issue of what is being produced. For example if many people were getting sick and required healthcare there would be a boost in GDP as this would account for economic activity, however this obviously does not concern welfare as it would be better if the people did not become ill in the first place. This can be summarised as uneconomic growth where economic growth brings about a decrease in the quality of life. This can be applied to the issue of using fossil fuels for energy; even though increased energy consumption usually corresponds with growth it may mean more pollution and adverse and harmful effects to our environment.
  • Finally, there is the issue of sustainable economic growth. There are many historic examples where there was a boost in GDP due to the discovery of new resources or the re-utilization of land or capital. However this growth would not be sustainable due to the scarcity of those resources. This would incur the miscalculation of GDP, and again fail to represent the welfare of the economy.

The use of gross domestic product can be useful to give a holistic view of a countries economy, however when looking at the welfare of an economy it fails to be an effective indicator because it does not involve factors such as happiness, and non-monetary activity within that country which directly attribute to peoples standard of living. This is why there are other approaches to the welfare of an economy such as the Human Development Index (HDI) or Gross National Happiness (GNH). The main issue with attempting to indicate a level of welfare within a country is that factors such as environmental sustainability can be difficult at times to quantify, and equally so with happiness. However, the dependence of GDP to indicate welfare of an economy and growth is becoming an outdated concept

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